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WHAT’S NEW IN THE EIGHTH EDITION:
There is a new Ask the Experts feature on "Trade Between China and the United States."
LEARNING OBJECTIVES:
By the end of this chapter, students should understand:
how everyone can benet when people trade with one another.
the meaning of absolute advantage and comparative advantage.
how comparative advantage explains the gains from trade.
31
© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website,
in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise
on a password-protected website or school-approved learning management system for classroom use.
3
INTERDEPENDENCE AND THE
GAINS FROM TRADE
32 ❖ Chapter 3/Interdependence and the Gains from Trade
how to apply the theory of comparative advantage to everyday life and national policy.
CONTEXT AND PURPOSE:
Chapter 3 is the third chapter in the three-chapter section that serves as the introduction of
the text. Chapter 1 introduced ten fundamental principles of economics. Chapter 2
developed how economists approach problems. This chapter shows how people and
countries gain from trade (which is one of the ten principles discussed in Chapter 1).
The purpose of Chapter 3 is to demonstrate how everyone can gain from trade. Trade
allows people to specialize in the production of goods for which they have a comparative
advantage and then trade for goods that other people produce. Because of specialization,
total output rises, and through trade we are all able to share in the bounty. This is as true for
countries as it is for individuals. Because everyone can gain from trade, restrictions on trade
tend to reduce welfare.
KEY POINTS:
Each person consumes goods and services produced by many other people both in the
United States and around the world. Interdependence and trade are desirable because
they allow everyone to enjoy a greater quantity and variety of goods and services.
There are two ways to compare the ability of two people to produce a good. The person
who can produce the good with a smaller quantity of inputs is said to have an absolute
advantage in producing the good. The person who has the smaller opportunity cost of
producing the good is said to have a comparative advantage. The gains from trade are
based on comparative advantage, not absolute advantage.
Trade makes everyone better o? because it allows people to specialize in those activities
in which they have a comparative advantage.
© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website,
in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise
on a password-protected website or school-approved learning management system for classroom use.
Chapter 3/Interdependence and the Gains from Trade ❖ 33
The principle of comparative advantage applies to countries as well as to people.
Economists use the principle of comparative advantage to advocate free trade among
countries.
CHAPTER OUTLINE:
I. A Parable for the Modern Economy
A. Example: two goods—meat and potatoes; and two people—a cattle rancher named
Ruby and a potato farmer named Frank (each of whom likes to consume both
potatoes and meat).
1. The gains from trade are obvious if Frank can only grow potatoes and Ruby can
only raise cattle.
2. The gains from trade are also obvious if, instead, Frank can raise cattle as well as
grow potatoes, but he is not as good at it and Ruby can grow potatoes in addition
to raising cattle, but her land is not well suited for it.
3. The gains from trade are not as clear if either Frank or Ruby is better at producing
both potatoes and meat.
© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website,
in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise
on a password-protected website or school-approved learning management system for classroom use.
Begin by explaining that there are two basic ways that individuals can
satisfy their wants. The rst is to be economically self-suCcient. The
second is to specialize in the production of one thing and then trade with
others. With rare exceptions, individuals and nations tend to rely on
specialization and trade. One way to demonstrate this is to survey the
students on their future plans (doctors, lawyers, teachers, etc.). Point out
34 ❖ Chapter 3/Interdependence and the Gains from Trade
Make sure that you write out all of the algebra involved in this example. If
you leave out steps, students will not understand how these calculations
are made.
B. Production Possibilities
1. Frank and Ruby both work eight hours per day and can use this time to grow
potatoes, raise cattle, or both.
2. Figure 1 shows the amount of time each takes to produce one ounce of either
good:
© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website,
in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise
on a password-protected website or school-approved learning management system for classroom use.
Chapter 3/Interdependence and the Gains from Trade ❖ 35
Figure 1
Minutes Needed to
Make One Ounce of:
Amount Produced in Eight
Hours
Meat Potatoes Meat Potatoes
Frank the farmer 60
min./oz.
15 min./oz. 8/1=8 oz. 8/0.25=32 oz.
Ruby the rancher 20
min./oz.
10 min./oz. 8/0.33=24 oz. 8/0.16=48 oz.
ALTERNATIVE CLASSROOM EXAMPLE:
Martha and Stewart each spend eight hours a day wallpapering and painting:
Hours Needed to Do One
Room
Rooms Finished in 40 Hours
Paint Wallpaper Paint Wallpaper
© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website,
in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise
on a password-protected website or school-approved learning management system for classroom use.
36 ❖ Chapter 3/Interdependence and the Gains from Trade
3. The production possibilities frontiers can also be drawn.
a. These production possibilities frontiers are drawn linearly instead of being
bowed out. This assumes that Frank's and Ruby's technology for producing
meat and potatoes allows them to switch between producing one good and
the other at a constant rate.
b. As we saw in Chapter 2, these production possibilities frontiers represent the
principles of trade-o?s and opportunity costs.
It is important to take the time to explain how to calculate the x- and
y-intercepts. Point out that Frank could produce 8 ounces of meat if all of
his time is spent on meat or 32 ounces of potatoes if all of his time is
4. We will assume that Frank and Ruby divide their time equally between raising
cattle and growing potatoes.
a. Frank produces (and consumes) at point A—16 ounces of potatoes and 4
ounces of meat.
b. Ruby produces (and consumes) at point B—24 ounces of potatoes and 12
ounces of meat.
You should emphasize that these production possibilities frontiers
represent the farmer’s and the rancher’s consumption possibilities
because we are assuming that there is no trade.
C. Specialization and Trade
1. Suppose Ruby suggests that Frank specialize in the production of potatoes and
then trade with her for meat.
© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website,
in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise
on a password-protected website or school-approved learning management system for classroom use.
Chapter 3/Interdependence and the Gains from Trade ❖ 37
a. Ruby will spend six hours a day producing meat (18 ounces) and two hours a
week growing potatoes (12 ounces).
b. Frank will spend eight hours a day growing potatoes (32 ounces).
c. Ruby will trade 5 ounces of meat for 15 ounces of potatoes.
Students will ask how this “price” is determined. Explain the range of
prices that each participant would be willing to accept.
2. End results:
a. Ruby produces 18 ounces of meat and trades 5 ounces, leaving her with 13
ounces of meat. She also grows 12 ounces of potatoes and receives 15 ounces
in the trade, leaving her with 27 ounces of potatoes.
b. Frank produces 32 ounces of potatoes and trades 15 ounces, leaving him with
17 ounces. He also receives 5 ounces of meat in the trade with Ruby.
3. In both cases, they are able to consume quantities of potatoes and meat after the
trade that they could not reach before the trade.
Prove to your students that it would take each of them more than eight
hours to produce these quantities on their own.
Figure 2
© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website,
in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise
on a password-protected website or school-approved learning management system for classroom use.
38 ❖ Chapter 3/Interdependence and the Gains from Trade
II. Comparative Advantage: The Driving Force of Specialization
A. Absolute Advantage
1. Denition of absolute advantage: the ability to produce a good using
fewer inputs than another producer does.
2. Ruby has an absolute advantage in the production of both potatoes and meat.
B. Opportunity Cost and Comparative Advantage
1. Denition of opportunity cost: whatever must be given up to obtain some
item.
Table 1
© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website,
in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise
on a password-protected website or school-approved learning management system for classroom use.
Chapter 3/Interdependence and the Gains from Trade ❖ 39
a. For Ruby, it takes ten minutes to produce one ounce of potatoes. Those same
ten minutes could be used to produce one-half ounce of meat. Thus, the
opportunity cost of producing an ounce of potatoes is one-half ounce of meat.
b. For Frank, it takes 15 minutes to produce one ounce of potatoes. Those same
15 minutes could be used to produce one-fourth ounce of meat. Therefore,
the opportunity cost of producing one ounce of potatoes is one-fourth ounce
of meat.
c. The opportunity cost of producing one ounce of meat is the inverse of the
opportunity cost of producing one ounce of potatoes.
Your students may have a hard time comprehending this. Make sure that
you go through these calculations several times and write out every step.
2. Denition of comparative advantage: the ability to produce a good at a
lower opportunity cost than another producer.
a. Frank has a lower opportunity cost of producing potatoes and therefore has a
comparative advantage in the production of potatoes.
b. Ruby has a lower opportunity cost of producing meat and therefore has a
comparative advantage in the production of meat.
3. Because the opportunity cost of producing one good is the inverse of the
opportunity cost of producing the other, it is impossible for a person to have a
comparative advantage in the production of both goods.
C. Comparative Advantage and Trade
1. When specialization in a good occurs (assuming there is a comparative
advantage), total output will grow.
© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website,
in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise
on a password-protected website or school-approved learning management system for classroom use.
40 ❖ Chapter 3/Interdependence and the Gains from Trade
2. As long as the opportunity cost of producing the goods di?ers across the two
individuals, both can gain from specialization and trade.
a. Frank buys 5 ounces of meat with 15 ounces of potatoes. This implies that the
price of each ounce of meat is three ounces of potatoes, which is lower than
Frank's opportunity cost of four ounces of potatoes. Trade is benecial to
Frank.
b. Ruby buys 15 ounces of potatoes for 5 ounces of meat. The price of each
ounce of potatoes is one-third ounce of meat. This is lower than Ruby's
opportunity cost of one-half ounce of meat. Trade also benets Ruby.
D. The Price of the Trade
1. For both parties to gain from trade, the price at which they trade must lie
between the opportunity costs.
2. In our example, Frank and Ruby must trade at the rate of between 2 and 4 ounces
of potatoes for each of meat.
© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website,
in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise
on a password-protected website or school-approved learning management system for classroom use.
Chapter 3/Interdependence and the Gains from Trade ❖ 41
Activity 1—Creating Comparative Advantage Examples
Type: In-Class Assignment
Topics: Specialization, interdependence, self-interest, comparative
advantage
Materials needed: 3-5 candy bars (or similar items to use as prizes)
Time: 15 minutes (rst day), depends on number of groups
(second day)
Class limitations: works in any size class
Purpose
This assignment allows students to further explore comparative advantage.
Instructions
Divide the class into groups of three or four to write a comparative advantage
problem of their own. Tell them to make creative, humorous, yet plausible
examples.
E. FYI: The Legacy of Adam Smith and David Ricardo
1. In Adam Smith's 1776 book An Inquiry into the Nature and Causes of the Wealth
of Nations, he writes of the ability of producers to benet through specialization
and trade.
2. In David Ricardo's 1817 book Principles of Political Economy and Taxation, Ricardo
develops the theory of comparative advantage and argues against restrictions on
free trade.
3. The benets of free trade are an issue that is generally agreed upon by most
economists, and the theories and arguments developed by these two individuals
200 years ago are still used today.
© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website,
in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise
on a password-protected website or school-approved learning management system for classroom use.
42 ❖ Chapter 3/Interdependence and the Gains from Trade
IV. Applications of Comparative Advantage
A. Should Serena Williams Mow Her Own Lawn?
1. Imagine that Serena can mow her lawn faster than anyone else can.
2. This implies that she has an absolute advantage.
3. Suppose that it takes her two hours to mow her lawn. In that same two hours, she
could lm a commercial for which she would earn $30,000. This means that the
opportunity cost of mowing her lawn is $30,000.
4. It is likely that someone else would have a lower opportunity cost of mowing
Serena’s lawn; this individual would have a comparative advantage.
5. Both she and the person hired will be better o? as long as she pays the individual
more than the individual's opportunity cost and less than $30,000.
B. In the News: Economics within a Marriage
1. The principles of comparative advantage and gains from specialization and trade
even apply to housework.
2. This article from Slate describes the division of housework between the author
and her husband, even though she has the absolute advantage in doing it all.
C. Should the United States Trade with Other Countries?
1. Just as individuals can benet from specialization and trade, so can the
populations of di?erent countries.
© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website,
in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise
on a password-protected website or school-approved learning management system for classroom use.
Chapter 3/Interdependence and the Gains from Trade ❖ 43
2. Denition of imports: goods produced abroad and sold domestically.
3. Denition of exports: goods produced domestically and sold abroad.
4. The principle of comparative advantage suggests that each good should be
produced by the country with a comparative advantage in producing that good
(smaller opportunity cost).
5. Through specialization and trade, countries can have more of all goods to
consume.
6. Trade issues among nations are more complex. Some individuals can be made
worse o? even when the country as a whole is made better o?.
D. Ask the Experts: Trade Between China and the United States
1. 100 percent of economic expert surveyed agreed that trade with China makes
most Americans better o?.
2. 96 percent of economic experts surveyed agreed that some Americans who work
in the production of competing goods are made worse o? by trade with China.
To help students reconcile these two survey results, point out that trade
makes most Americans better o? and only makes a small group of
Americans worse o?.
To help convince students that importing goods is not harmful to a
country, ask the students to devise a way to produce co?ee domestically.
Point out that it is possible to grow co?ee beans in the United States in
enclosed nurseries, but the opportunity cost of the resources used would
© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website,
in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise
on a password-protected website or school-approved learning management system for classroom use.
44 ❖ Chapter 3/Interdependence and the Gains from Trade
Discuss how di?erences in resource endowments can be signicant
factors in determining opportunity cost and comparative advantage. Such
di?erences include climate, soil composition, education and training of the
labor force, capital stock, and infrastructure.
© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website,
in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise
on a password-protected website or school-approved learning management system for classroom use.
